1. Field of the Invention
This invention relates generally to risk assessment, and more particularly to systems and methods of evaluating risks associated with financial transactions.
2. Description of the Related Art
Most financial transactions involve a customer making a payment in exchange for goods or services from a merchant. Many times the payment is in a promissory form that instructs the customer's bank to pay the merchant. A check is one example of such a promissory form of payment. As is well known, the funds promised by the check are sometimes not paid due to reasons such as insufficient funds in the customers' checking accounts or fraud. Thus, the merchant is taking a risk whenever a check is received as a payment. Many merchants maintain local databases that include, for example, a list of check writers that have written bad checks in the past. Such databases may range from a simple list on paper for a small store owner to a computer network for a chain store. However, these databases typically include only names of check writers who have previously presented bad checks to the particular merchant and do not identify check writers who have written bad checks elsewhere. Moreover, managing such databases requires use of merchants' resources that could otherwise be used more beneficially.
In order to better manage financial transaction risks, many merchants subscribe to an agency that assesses risks associated with financial transactions based largely on the check writer's transaction history with all merchants who subscribe to the agency's service. For a given transaction, a subscribed merchant sends a transaction approval request to the agency with information such as check amount, check identifying information, and information about the check writer. The agency assesses the risk and typically generates a risk score for the transaction. The agency then either approves or declines the transaction based on the risk score. The level of subscription to such an agency can vary, from an approval service to the agency assuming the risk of the transaction by either guaranteeing the check or purchasing the check from the merchant.
In order to assess a transaction risk, the check approval agency typically calculates a risk score by inputting information about the transaction including the check, check writer, and merchant into an algorithm. The algorithm then returns the risk score that is indicative of the transaction risk. The agency then either approves or declines the transaction based on the risk score. Disadvantageously, most traditional risk assessment algorithms are designed to calculate transaction risk scores strictly based on the probability of the transaction or check being returned. Transactions with a probability of failure beyond a threshold level are automatically declined without taking into consideration factors such as the potential financial benefit generated by the transaction.
Some checks that have unsatisfactory risk scores calculated based on the traditional algorithms may however generate higher than average profit for the check approval agency, which in turn may be financially advantageous for the agency to approve the check despite of a less than satisfactory traditional risk score. For example, transactions from check writers who have a history of writing bad checks but always paid upon collection can actually be more profitable for the check approval agency because the transaction will result in not just the standard fee but also an additional surcharge for the returned check. Conventional risk assessment systems generally do not take into account of factors relating to the profitability of the transaction when evaluating transaction risks, thus often providing an incomplete and sometimes inaccurate assessment of whether to approve or decline a transaction. As a consequence, a significant portion of transactions that could potentially be beneficial to both the merchant and the check approval agency is not identified and captured.
Hence, there is a need for an improved method of assessing transaction risks that evaluates risks based on the potential financial benefit generated by the transaction. To this end, there is a need for a system and method for determining whether to approve or decline a check transaction based on the potential profit or loss generated by the transaction.